The first thing to discuss is that there don't appear to be any bearings in the end of the stuffing tube. Your shaft is clearly smaller than the internal diameter of the tube, so you need a bearing at each end of the tube. If you haven't already done so, can you search through your fittings and see if there are two brass/bronze collars that look like they would be a tight push fit in each end of the tube and are a snug fit around the shaft? If you try and fit things as they stand you will end up with a very noisy, leaky arrangement (o-rings notwithstanding). If you cannot find any bearings, I suggest you buy a ready made tube with bearings included (which will almost certainly include a new shaft, but that's better than no bearings at all). There are plenty available on the internet, such as
these.
On the subject of o-rings - no, you don't need them. Assuming you get some bearings of the right size in each end of the tube, a little bit of waterproof grease will see you home and dry (!). You could usefully put a brass washer between the locking nut and the end of the tube, and similarly on the inboard end for when you run in reverse.
Play in the propshaft - you need a tiny bit of play, enough that when you push and pull you can feel there is a little movement, but not so much that you can actually see it move. You are looking for as tight a fit as you can without there being any binding as the shaft rotates.
And this hardware should be fine with a 40mm prop. If you get the bearings in place.
Hope that all helps.
Greg